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U.S. Losing Its Competitive Edge

Various global reports published last month show the U.S. losing its competitive edge.

The U.S. dropped to sixth place from its previous first-place position in the 2006-07 World Economic Forum’s Global Competitive Index (GCI) rankings.

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The U.S. fares better in this year’s "Ease of Doing Business" report, published by the World Bank and International Finance Corporation, where we rank third behind Singapore and New Zealand.

A remarkable story is unfolding around the globe, as the Doing Business study reveals. The report quantifies significant, widespread and aggressive reform activity in countries that aim to improve their economic and business climates. Georgia, Romania and Mexico are the top-three reformers. China and France make the top-ten reform list too, as do Ghana and Tanzania. The U.S. is not a top-ten reformer.

According to the report, the most popular reform in 2005-2006 was “easing the regulations on starting a business. Forty-three countries simplified procedures, reducing costs and delays.” Second on the popular reform list was “reducing tax rates and the administrative hassle that businesses endure when paying taxes.”

While other nations are stepping up reform efforts to improve their tax and regulatory environments, here in the U.S., even simple measures get tangled in political side shows. Every politician talks about improving competitiveness, yet the productive output of Congress, in general, is relatively low when it comes to results.

The list is long regarding steps and strategies for improving U.S. competitiveness. Thinking big with respect to reform, however, is not practical given the current political climate. Even getting extensions on proven tax incentives is a grating chore. That certainly has been the case with the research and development (R&D) tax credit, which expired at the end of 2005. The tax credit has proven to be a boon for U.S. innovation and competitiveness. Every dollar of the benefit has translated into an additional dollar in private R&D, according to the U.S. Bureau of Labor Statistics.

Yet, despite the bipartisan support the credit lays claim to on Capitol Hill, it has lapsed twelve times throughout its 25-year history. This non-committal approach to R&D tax policy is hurting U.S. competitiveness. Firms need certainty in planning projects, which are often multi-year initiatives.

The current Congress has one more opportunity to address the issue when it returns to Washington for a post-election lame duck session. If they don’t act, many businesses will experience capital losses, as the cost of R&D projects significantly increased with the lapse of the credit at the end of 2005.

Not surprisingly, other countries have implemented R&D tax incentives as a result of the U.S. experience. Now, money is moving overseas where tax incentives are more robust and certain.
According to the American Electronics Association (AEA), “U.S. affiliates invested $28.8 billion on R&D in foreign countries in 2003, the most recent data available, up 72 percent from 1999.” In total, U.S. industry spent $184 billion on R&D in 2004, but spending has flattened signaling a troubling trend for American-made innovation.

Click here to view AEA’s "Competitive Series" report on the R&D Tax Credit.

It’s not just the big guys investing in R&D. Between 14,000-16,000 companies use the tax credit, many of which are small. In fact, according to the Small Business Administration Office of Advocacy, small firms are responsible for the bulk of U.S. innovation. They produce 13 to 14 times more patents per employee than large firms, for example, and employ 41 percent of high tech workers, such as scientists, engineers, and computer workers.

These firms are constantly finding new ways to produce their products in a more efficient, safe and innovative manner – in effect they are participating in R&D activities and adding to the competitiveness of the nation.

According to the Internal Revenue Service (IRS), “R&D expenditures generally include all expenditures incident to the development or improvement of a product.” So expenditures that include those associated with obtaining a patent, such as attorney's fees, may qualify for the tax credit. Any “reasonable costs” a firm incurs in its “trade or business for activities intended to provide information to help eliminate uncertainty about the development or improvement of a product” can be considered R&D, according to the IRS. “Neither the nature of the product (or improvement) being developed, nor the level of technological advancement matters when making this determination.”

The manufacturing sector, which every politician claims to be rallying behind, is the largest “user” of the R&D credit. In a recent letter to Congress urging the extension, permanency and strengthening of the credit, National Association of Manufacturers (NAM) President John Engler wrote “nearly 60 percent of all private industrial R&D in the United States is performed by manufacturers and manufacturers claimed nearly 70 percent of federal R&D credits in 2003.”

While securing an extension of the R&D tax credit is critical this year, its permanency and enhancement will bring the U.S. back to competitive levels in the global arena. A September 2006 report by the Information Technology and Innovation Foundation (ITIF) found that the generosity of the U.S. tax credit has declined in comparison to the rest of the world.
Where the U.S. once provided “the most generous tax treatment of R&D among the OECD nations in the early 1990s, by 2004 the United States has dropped to 17th,” according to ITIF. In addition, Canada, Australia, Mexico, Singapore, Spain and the UK provide significantly more generous tax treatment of R&D for small firms.

These countries, and many others, market directly to U.S.-based firms encouraging them to “come and invest.” Indeed while Virginia may still be tops for lovers, China is for R&D as their tax credit is more powerful and permanent.

Business legend Jack Welch once said, “An organization's ability to learn, and translate that learning into action rapidly, is the ultimate competitive advantage.”

As the Doing Business study makes clear, other countries are learning – and more significantly acting rapidly — on reforms that are positioning them for competitive advantage. This is a good thing, as global economic growth means a more peaceful, prosperous and collaborative world.

However, U.S. political leaders need to get with the program. Their inaction and fiefdoms are enabling our nation’s competitive slide.

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Karen Kerrigan is president & CEO of the Small Business & Entrepreneurship Council, a research and advocacy group based in Washington, D.C. that works to protect small business and promote entrepreneurship. She is also founder of Women Entrepreneurs, Inc., an association helping women business owners succeed through education, networking and advocacy. Kerrigan can be reached at kkerrigan@sbecouncil.org.